Debt sometimes is inevitable, particularly in periods where your circumstances involve a decrease in overall income. To get control over your debt, debt consolidation and debt management are viable options. However, because these methods of handling debt are very different -- true consolidation always pays your debt in full, whereas debt management does not -- they have different impacts on your credit report and score. This influences how easy it is to repair your credit.
How Debt Management Works
In a debt management program (DMP), you hire a company to be a middleman between you and your creditors. You send them all the money you'd normally pay directly to the creditors, and then the debt management company pays your bills on your behalf. As part of their services, debt management companies also usually try to negotiate lower interest rates, lower monthly payments or forgiveness of some or all of the debt (debt settlement). If you're working with a for-profit company, you pay for the convenience of having someone else deal with each creditor.
Debt Management and Credit Repair
Any time you pay less than the full amount on your account balances, creditors usually note your accounts as "not paid as agreed." Because of the way debt management companies negotiate for you, the accounts you involve in the debt management likely will have this note. This doesn't necessarily impact your credit score, but it can make it harder to get new credit after the program, as any negative note on your credit report stays on the report for seven years. With debt management, accounts usually are suspended or closed, and you can't take on new accounts. Subsequently, your ability to open new accounts that could establish a better history is limited. Credit scores tend to dip during the first few months of a debt management plan if you are using less than 50 percent of your available credit, according to Vision Credit Education, Inc. They then gradually rise. Despite these issues, debt management often helps repair credit because it helps you get out from under the debt you have, with your debt management company making consistent payments on your behalf.
The Basics of Debt Consolidation
Many companies refer to debt management services -- including debt counseling -- as debt consolidation, but the two services are not the same. With true debt consolidation, you take out a new loan to pay off old ones. Consolidation thus is a form of refinancing. When you take out a consolidation loan, you can get better rates of interest and get a monthly payment minimum that works better for your budget, depending on your credit score and the term length of the loan. Like debt management, consolidation means you end up paying just one company what you owe. Unlike debt management, however, you always pay off your old loans in full. The terms of the old debt don't change; you reap financial benefits through the terms of the new loan, not by negotiating about old accounts.
Debt Consolidation and Credit Repair
Normally, debt consolidation doesn't ding your credit much, if at all, because you always pay 100 percent of your old debts. Your accounts appear as "paid in full," the best status they can have. However, your credit history length makes up 15 percent of your credit score. Consolidation can hurt your score if you close the accounts you pay off because closed accounts can truncate your history. How you've paid on your accounts -- on time or late, in full or partial -- makes up an additional 35 percent of your credit score. If you close accounts and just pay your new creditor, you end up making fewer payments, so your credit score may not rise as fast. Your score can drop if you miss a payment on the consolidation loan, just as if you missed payments with your old creditors.
The Bottom Line
Both debt consolidation and debt management can hurt or improve your credit based on what you do after entering the consolidation or management. Overall, however, debt management is riskier because of the fact you don't pay your old debts as agreed. Many people in need of credit repair can't use consolidation, however, because consolidation requires qualifying for a new loan.
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